Free trade is preferable to preferential trade

One of the most striking features of the economic environment of the past two decades has been the extent of the trade liberalisation carried out by the global community. Many large multilateral organisations such as the World Bank and the International Monetary Fund (IMF) have regularly promulgated advice based on the belief that openness generates predictable and positive consequences for economic growth. As a result, many countries have voluntarily undertaken reform programmes aimed at reducing their trade restrictions. Indeed, integration into the world economy has proved to be a powerful means for countries to promote economic growth and development and to substantially reduce poverty.

This does not mean that any step towards trade liberalisation is necessarily a positive one. Well-known international economist Jagdish Bhagwati notes that bilateral or, more generally, regional trade agreements are stumbling blocks to eventual multilateralism. Therefore, the proposed trilateral agreement between South Africa, India and Brazil should be seriously reconsidered if the welfare of the people in existing trading partner countries as well as that of the proposed partner countries is to be increased. But one might ask, if free trade is economically the most efficient policy, how can it be that such a move towards free trade can result in reduced economic efficiency?

Analysis shows that not all increases in trade flows within a preferential trading agreement can be counted as gains. As a result of trade diversion members of the preferential trading agreement can sometimes end up buying from higher cost sources – their partners within the preferential agreement – rather than from more efficient producers outside the agreement. Furthermore, a complex web of costs arises from the need to observe rules of origin when preferential trade agreements require a substantial proportion of the components of a good to originate in the member country.

However, carefully considered agreements do create new opportunities for gains from trade. Free trade areas create trade that would not otherwise have existed. One of the potential gains from tariff reductions between trading partners is that more efficient producers in partner countries replace inefficient local producers. In most cases trade creation raises a country's national welfare.

In general, the most effective way to ensure that trade liberalisation leads to efficiency improvements is if a country removes its trade barriers against all countries. Indeed, it is estimated that the potential gains from eliminating trade barriers in the global economy are considerable. In fact, the World Bank estimates that if we were living in a tariff free world, income around the globe would increase by $832 billion as a result of increased trade in all goods. Most of these gains ($539 billion) would flow to developing countries.

How should South Africa respond? South African consumers would benefit from the relatively cheaper goods that unfettered free trade would bring. Similarly, consumers in the E.U. would benefit from a reduction in the barriers to the importation of agricultural goods originating on the African continent. At the same time, producers in countries that reduce barriers to trade would benefit from access to lower-cost resources. Exports are facilitated by reduced costs of production, resulting from access to low-cost imported components. Trade barriers impose significant costs on consumers as well as on most producers and the only winners are government and those producers that rely on captive consumers to cover their uncompetitive prices.

Large economies, such as those of the United States and the European Union, should encourage trade negotiations at a multilateral level. If they were to withdraw some of their more problematic demands upon developing nations, such as the extreme environmental restrictions, and substantially reduce the subsidies to their producers, they would bring about great welfare gains, not only in the developing countries but also in their own economies. Free trade requires the co-operative endeavours of all nations. A concerted effort among the governments of all countries is necessary to move toward a world without trade restrictions. The benefit of success will be increased welfare for all.

It is therefore both unfortunate and inappropriate that the EU trade commissioner Peter Mandelson announced yesterday that the 25 nation bloc would not be making any more agricultural tariff cuts to further open up the European market. Many African countries will suffer as a result of this stance. Indeed, a World Bank study estimated that European Union trade regulations cost African exporters approximately US$400 million in exports of cereals, dried fruits and nuts each year. If next month’s WTO meeting in Hong Kong is to result in any meaningful benefits for millions of consumers worldwide, especially those in poor African countries reliant on agricultural exports, the EU stance will have to change. Otherwise we are facing a repeat of the 2003 WTO Cancun debacle.

Author:Jasson Urbach is an economic researcher at the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article/ 22 November 2005